Twenty years ago, in July 1997, Asia was shuttered by an historic recession marked by investors fleeing the region and population plagued by layoffs and inflation.
Until the eve of the crisis, global financial institutions were blinded by what they perceived as an irresistible Asian take-off based on export-oriented economic policies. They blatantly disregarded the dangers of a dependency to short-term foreign credits and real estate speculation. Sadly, in a matter of a few days the house of cards crumbled.
Fast-track to 2017: Asian countries seem at first glance to have addressed their systemic weaknesses. Flexible or semi-flexible exchange rates have enabled them to regain competitiveness, stimulating exports. Their current balances now generate surpluses.
The now mature Chinese economy displays also reassuring signs of healthiness. Last week Beijing announced that the Chinese GDP grew in the second quarter of 2017 by 6.9 percent, higher than the official target of growth set by the authorities at 6.5 percent for the year. Growing domestic demand and robust global trade have fueled a steady increase of industrial production.
Yet these numbers just tell part of the truth. Most of this growth relies on consumption credit and debts. For years, Beijing has been supporting its economy with massive monetary and fiscal stimulus packages, successfully sustaining demand but also allowing a strong surge in indebtedness.
China’s total debt (households, non-financial enterprises, government and local authorities) now exceeds 250 percent of GDP, compared to 151 percent at the end of 2006.
By opening up the floodgates of credit, Beijing has contributed to the production of large industrial overcapacity and bubbles formation, particularly in real estate. Despite promises by Chinese President Xi Jinping to strictly control the debt of state-owned enterprises and local governments, Moody's has for the first time degraded China’s credit rating (from A3 to A1).
If the conditions for granting credit have been recently tightened, much more drastic reforms are needed. However, the political economy equation is delicate.
A few months away from a crucial Chinese Communist Party congress in the Fall during which Xi Jinping hopes to secure a new five-year term, decisions that would slow down growth considerably to ensure the stability of the financial system are unlikely to be taken.
A repeat of the 1997 scenario should be avoided. A majority of China's debt is denominated in yuan and held within the country which limits the risk of turbulence and contagion as it does not depend on the control of foreign creditors but instead on loans issued by state-owned banks. China also sits on hefty reserves that it could mobilize.
Yet the long-term risks run deeper than a cash flow balance. By allowing a growth based on debt rather than innovation, China is favoring companies unable to create wealth and develop the technologies that would dominate markets in the future.
Debt financed production overcapacity is also the cause of the regular pollution hikes across the country. The thick toxic fogs are a testimony of the persistence of the production surpluses that the Chinese government fails to prevent. These lead to price dumping and the ire of Western countries prompt to raise the threats of a return to protectionism that would be catastrophic for China.
Beijing is not totally inactive however. To reduce the frenziness of foreign acquisitions that further increase its debt, the Chinese authorities have placed under surveillance four of its most high profile international companies: HNA (which bought the Hilton group), Wanda and its studios in Hollywood, the tourism complex giant Fosun and Anbang who made headlines by buying palaces and landmark hotels such as the Waldorf Astoria in New York.
The message is clear: Beijing will not tolerate reckless investments from adventurous entrepreneurs. Instead the focus should be on productive infrastructure deals in key sectors: energy, natural resources and transportation.
The main vehicle of this strategy is the central project defended by President Xi Jinping of “One Belt One Road”, an initiative aimed at reducing the logistics obstacles and resources scarcity that hamper Chinese trade. The election of Donald Trump and his antagonistic position towards China has further reinforced the determination of Beijing to sign key international partnerships based on infrastructure developments and the reaffirmation of free trade.
This new proactive role from China was most obvious at the G20 summit when Xi Jinping and European leaders isolated Donald Trump to promote an intensification of globalization. It can be further witnessed in the increase appetite from Chinese consortiums in developing mining, energy or highways projects in Central Asia, Africa and Latin America.
Race against time
What is at stake is the confrontation of too logics, a race against time both at home and abroad. Domestically, Beijing hopes to curb the shopping spree of entrepreneurs and speculators eager to make headlines and favor instead the financing of infrastructure worldwide to open new markets for its companies.
Globally, China is making a strong push to become the new champion of globalization, filling in the void left by the United States after the election of an isolationist Donald Trump. While the new American administration brandishes threats of protectionism and walls, Beijing takes the center stage in negotiations on trade, climate change mitigation and development aid.
The long term stability of Asia depends on the capacity of Beijing to both limit the increase of unsustainable debts while further encouraging the deepening of economic globalization. The economic fundamentals of Asian countries are much more solid in the short term than they were at the eve of the 1997 crisis.
However in the long run, to ensure the sustainable development of the region, Beijing must quench the speculation/debt cycle and instead finance the key global infrastructures needed to further integrate world markets and absorb current productive overcapacities.